How to Increase Your Law Firm Profitability for the Long Term
Finding ways to consistently improve profitability is a top priority for any law firm. But in the face of changing customer preferences, the rising popularity of digital experiences, and a slew of market uncertainty—that can be easier said than done. Understanding how to identify and maximize the various aspects of your firm’s performance is essential to ensuring you have the resources to grow and succeed in both the long and short term. With a healthy profit margin, you’ll be in a better position to better serve clients, attract the best talent, and better capitalize on strategic opportunities.
While there’s no one solution to improve law firm profitability, there are a number of considerations that can help you get started. In this post, we’ll go over the key metrics that contribute to law firm profit, methods for boosting revenue and operational efficiency, and the available technology to help you maximize your efforts.
What Is Law Firm Profitability?
Like all businesses, a law firm is profitable when it spends less on overhead expenses than it makes over a given period. But unlike most businesses, law firm billing is a lot more complex and subject to more stringent rules than other industries. This can make tracking a firm’s financial health challenging, especially when many attorneys are not explicitly trained on the finer points of law firm economics and profitability.
To start, let’s quickly go into the important distinction to make between increased profits and increased revenue. While it might seem like taking in more revenue from more clients and work should naturally lead to more profits, that isn’t always the case. Without finding ways to streamline your firm’s processes and cut costs, that extra work can add more operational costs that cut into your profits and put your financial health at risk. However, haphazardly implementing cost-cutting measures is equally dangerous as it runs the risk of inadvertently adding more complexity and reducing client satisfaction.
Speaking generally, here’s how you can calculate your firm’s profit:
- Revenue - (Cost of Attorney’s Time + Client Costs) = Gross Profit
- Gross Profit - Overhead = Net Profit.
What Are Key Metrics for Measuring Law Firm Profitability?
Improving your profitability without sacrificing the quality of your services can be challenging. It all starts by gaining a full, unbiased view of the important legal KPIs (key performance indicators) that influence your firm’s success. Tracking these metrics gives you a meaningful understanding of how your firm is doing currently, helps you identify areas for improvement, and allows you to set goals for the future.
While there are hundreds of potential data points you can track, below are some of the most important when it comes to a firm’s profitability:
Cash flow refers to the total amount of money coming in and out of your law firm. Maintaining sustainable positive cash flow is important to keep everything running smoothly in the short term and for growing your business in the long term. Because lawyers often don’t get paid immediately, finding ways to better manage cash flow is imperative.
Tracking your cash flow is the best way to hone in on what’s most profitable and where your biggest inefficiencies lie. Having accurate and up-to-date cash flow metrics is also invaluable for making financial projections, which in turn are useful for creating strategies for your law firm’s success.
Utilization rate measures an attorney’s billing efficiency and overall productivity. It’s measured by tracking the total hours worked against the number of hours that were billed. This helps you keep a close eye on the hours attorneys spend on non-billable items such as meetings and other internal tasks.
To put this into action, if a lawyer spends 50 hours a week in the office and spends 35 of those hours on billable tasks—their utilization rate is 70%. This is an incredibly useful KPI to track because it can help you start to find inefficiencies in your daily operations that are cutting into your profits.
A realization rate is the number of billable hours you’ve accrued vs the amount you’ve successfully invoiced. For example, if an attorney bills all clients for 1,000 hours of billable work and is able to collect 600 hours worth of fees then their realization rate is only at 60%.
Low realization rates have a number of potential causes, including inefficient or inconvenient payment methods or an ineffective pricing strategy. It could also be due to more mundane (but equally important) reasons such as errors made during manual time tracking or other traditional billing processes. Like utilization rate, tracking realization rates is worthwhile because it can uncover patterns in cash flow that are indicative of wider issues.
Billable and Non-Billable Hours
While utilization and realization rates are helpful indicators of an attorney’s performance, it doesn’t paint a complete picture. A certain amount of non-billable tasks are inevitable but it’s worth asking if all of those tasks need to be done by the attorneys themselves. Having a clear breakdown of non-billable hours can help you pinpoint which tasks could be delegated to paralegals, accounting specialists, or in some cases, automated by legal billing and accounting software.
Outstanding A/R Balances
The internal perception of a law firm’s performance can be heavily skewed if they maintain a high outstanding accounts receivable (A/R) balance. Without an effective A/R management strategy, the number of non-paying clients can increase along with the work that’s spent chasing down unpaid invoices.
In some cases, a high A/R balance might indicate client satisfaction issues, especially if a client doesn’t clearly understand the value of the work that was done on their behalf. However, for many firms, high A/R is the result of inefficient, manual billing and collection processes or overly-strict payment terms. Regardless, identifying the causes behind your firm’s outstanding A/R balances is another key ingredient to improving cash flow and profitability.
How to Increase Your Law Firm’s Profitability
Regardless of your firm’s size or practice area, tracking your financial data is a great starting point as it will help you hone in on problem areas and make better decisions. As you get a clearer picture of your firm’s financial health, there are a few specific aspects of your firm’s operations you can consider when finding opportunities to drive profits:
Set and Track High-Quality Goals
Almost every law firm’s goal is to increase profitability—but that doesn’t mean it will just happen. Instead, you should focus on setting goals that are specific, and quantifiable, and have a clear way to achieve them in a set amount of time. This style of strategic planning is called setting SMART goals and has been used successfully by businesses for decades.
Integrating legal accounting and billing software into your daily operations is a great way to improve law firm goal-setting. The reason data-driven decision-making is so important to law firm economics and profitability is that it lets us escape from nebulous goals that sound good on paper but don’t mean much in practice. Armed with an accurate view of your firm’s performance, you can then set actionable goals (for example: reducing non-billable hours or improving realization rate) that you can monitor each quarter or every year.
Bill and Collect Efficiently
A common reason for a high A/R balance or low cash flow is a simple one: outdated or inefficient billing process. Digital experiences have transformed how customers prefer to pay for services, and their expectations have changed as a result. The legal industry is no different, and yet many law firms still insist on taking paper checks or other antiquated payment methods.
Specialized legal billing software solutions provide an easy way to modernize and streamline your collection and payment processes. Offering user-friendly digital payment options, such as eCheck or credit card, not only improves the client experience but results in faster payments without spending more hours on collections.
Like many items on this list, reducing expenses can only start by tracking your financial data so you know exactly what those expenses are. That way, instead of indiscriminately cutting costs and headcount you can take a more measured, strategic approach.
These are a few common questions law firms ask when reducing overhead:
- Are we paying for any unused (or barely used) online subscriptions and services?
- Are there any non-billable hours that could be outsourced to a non-attorney?
- If there are non-billable hours we can’t outsource, are there tools we can use to make them more efficient?
- Do we still need the same amount of office space?
While these are just a few of the issues that may arise, you may be surprised what expenses are racking up without you realizing it. Modern legal accounting software makes tracking these expenses much easier, giving you a good foundation to make smarter budgetary decisions.
Automate with Legal Software
The biggest way a hard-working lawyer misses out on profits is by spending too much time on non-billable work. This is especially true for small firms or independent attorneys who can’t afford a dedicated accounting or paralegal team. Most industries are incorporating automation into their day-to-day operations to boost efficiency and give workers more time to focus on important tasks. While the complexity of legal operations used to make this near-impossible, there are now a number of specialized legal accounting and case management solutions available.
With the right technology partner, lawyers can automate administrative tasks such as practice management, client intake, time-tracking, billing and collections, and more. Automating these essential pieces of law firm operations enables you and your team to increase your caseload without sacrificing the quality of work.
Offer Alternative Ways to Pay
When it’s easier for clients to pay their legal bills, your firm gets paid faster. In addition to streamlining accounting practices, legal billing solutions also make it easier than ever to implement innovative and convenient ways for clients to pay. Simply by offering credit card and other digital payment options, law firms can consistently get paid faster and more reliably. In fact, law firms that accept online payments get paid 32% faster than those that don’t, according to the 2022 Benchmark Report from MyCase anonymized data.
The flexibility and customization of modern software also open up opportunities to offer new payment models entirely. Many firms are leveraging the latest technology to move away from the billable hour and offer client-friendly alternative billing methods, like flat-fee pricing, subscription-based models, and sliding-scale fees. Additionally, you could consider offering a customized payment plan, alleviating the pressure that comes from asking a client to pay for services all at once.
Ready to Boost Your Firm’s Profitability?
Ultimately, improving law firm profitability isn’t just about earning more money—it goes hand in hand with providing a superior client experience and improving your firm’s reputation. In other words, by finding ways to boost an attorney’s performance and efficiency, you also free up time for more collaboration, goal-setting, and the important work that matters most.
Leveraging a modern legal billing solution like LawPay can help forward-looking law firms streamline payment processes while helping you find opportunities for increased growth and revenue. With built-in A/R Management, online payments, billing automation, and seamless integrations with popular accounting and case management software, LawPay gives you a painless way to boost your profits without adding complexity to your day-to-day.
To find out how LawPay is helping thousands of practices around the country get paid faster, schedule a demo today.